Capturing differences between free and controlled immigration: Country bilateral data

Assaf Razin, Jackline Wahba04 March 2011

Do immigrants just move for the benefit systems? This column argues that the effect of the welfare state on immigration and its composition depends on whether the destination country's migration policy is “free” or “managed”, and on whether the source country is developed or developing.

Public debate on immigration has increasingly focused on the ageing welfare state amid concerns that unskilled immigrants are a fiscal burden as recipients of the generous welfare state. Indeed, under free labour mobility the fiscal strength of the welfare-state institutions is severely undermined. A moment's glance at the data would suggest that countries with more generous welfare systems also have relatively more unskilled immigrants. Table 1 shows that the average aggregate social spending as a percentage of GDP for 14 EU countries together with Norway and Switzerland, between 1980-1995, is around 21% compared to around 18% in the US, 17% in Canada, and 13% in Australia.1 A noteworthy characteristic of immigration between the EU and the US/Canada/Australia is the higher relative skill composition of immigrants in the latter countries.2

Obviously, this is a pretty naïve view. In fact, previous studies have found mixed evidence on welfare migration (e.g. Borjas 1999, Brueckner 2000, and Levine and Zimmerman 1999). Indeed, the effect of welfare programmes on immigration and its composition depends on the policy regime, namely whether migration is free or restricted. In other words, the generosity of the welfare state may affect the skill composition of immigrants differently, depending on the immigration policy adopted.

Why the migration regime matters

In a free-migration regime, a typical welfare state with relatively abundant capital and high total factor productivity (implying relatively high wages for all skill levels) attracts both unskilled and skilled migrants. On the other hand, the generosity of the welfare state attracts unskilled (poor) migrants, as they expect to gain more from the benefits of the welfare state than what they expect to pay in taxes for these benefits. That is, they are net beneficiaries of the generous welfare state. In contrast, potential skilled (rich) migrants are deterred by the generosity of the welfare state. Thus the generosity of the welfare state shifts the migrant skill composition towards the unskilled.

In the restricted-migration regime, meanwhile, these same considerations lead host-country voters to open the door wide to skilled migration and slam the door shut on unskilled migration. Voters are motivated by two considerations: how migration affects their wages, and how it bears on the finances of the welfare state. Typically, unskilled migration depresses the unskilled wage and boosts the skilled wage. The opposite occurs with skilled migration. The effect of migration on the finances of the welfare state is common to all voters of all skills, because skilled migrants are net contributors to the welfare state, whereas unskilled migrants are net beneficiaries. From a public finance point of view, native-born voters of all skills would therefore opt for the skilled to come and for the unskilled to stay away to mitigate the fiscal burden. Hence, there is a need to consider the migration regime when examining the effect of the generosity of the welfare state on migration (see Razin et al. Forthcoming).

The EU as a case study

In a recent paper (Razin and Wahba 2011), we test how the generosity of the welfare state affects the skill composition of the immigrants across these policy regimes. We use free-movement within the EU (old core) to examine the free migration regime and compare that to immigration into the EU from two other source-country groups to capture immigration-restricted regime. We distinguish between immigration from developed versus developing countries after standardising cross-country education quality differences by using the Hanushek-Woessmann (2009) cognitive skills measure.

Policies controlling for immigration typically ignore differences in the educational quality of source countries. Thus immigrants with the same years of schooling may be treated equally in a points system, although in reality they may vary in their labour market productivity, causing different fiscal burdens. This may introduce a bias in estimates – in particular for least-developed countries. On one hand, if immigration policies favour higher educational attainment immigrants and one does not control for the quality of education, this would overestimate the effect of skill composition for least-developed countries. On the other hand, if high educated immigrants are of poor quality then their productivity would not be that different from the low-skilled ones and they would behave similarly to the low-skilled migrants – in being net recipient rather than contributors to the welfare state, resulting in an underestimate of the effect of welfare generosity on the skill composition. Thus not controlling for educational quality is problematic since a priori it is unknown which way that would bias the results.

Although we argue that the generosity of the welfare state (measured as social spending per capita) may affect the skill composition of immigrants, it is also plausible that the skill composition of migration itself may influence the voters' attitude towards the generosity of the welfare state. Voters in the host country are likely to boost its welfare system when absorbing high-skill migration and curtail it when absorbing low-skill migration. We deal with this endogeneity concern in our empirical analysis.

Finally, given that welfare considerations may be one aspect affecting the skill composition of immigrants, we also control for the differential returns to skills in both the source and the host country. The higher the returns to skills in the host and the lower the returns to skills in the source country, the more positive is the effect on the skill composition of immigrants (Borjas 1987). In addition, to capture recent immigration policies, we take into account family re-unification schemes, using past immigration stocks, and the number of refugees and asylum seekers admitted, both of which are likely to adversely affect the skill composition of immigrants.

The generosity of the welfare state: A magnet or a burden?

We find evidence that the generosity of the welfare state adversely affects the skill-composition of migrants under free-migration. But we also find that the generosity of the welfare state exerts a more positive effect under a policy-controlled migration regime relative to a free-migration regime, even after controlling for the differential returns in skills in source and host countries.

These results hold for both developed and developing countries, but the effect at first seems to be larger for developed countries. Once we adjust for educational quality, the effect of welfare-state generosity on skill composition increases for immigration from developing countries and converges to that experienced by immigration from developed countries.

Policy implications

It is clear from our analysis that immigration policies favouring high-skilled migrants need to take into account educational quality. Hence, a selective immigration scheme based on years of education solely will not be as effective in identifying the high skilled as a points-based system where ability (for example, language ability and labour market experience) are considered.

Another important implication of our findings is that under free migration, the generosity of the welfare state acts as a magnet for the unskilled. This suggests that harmonising the minimum welfare provision within the EU may be an attractive option to reduce the negative effect of the welfare state on the skill composition of non-EU immigrants under free migration.

1 Norway and Switzerland benefit from labour-mobility agreements with the EU.

2 It is puzzling that the UK migration policy targets net migration, rather than the skill mix of immigration, given the current UK fiscal stance. The Financial Times editorial on 6 February 2011 about Cameron’s costly migration policy argues that “To meet the target of cutting net migration to fewer than 100,000 a year, the number of non- nationals entering the UK is reduced, while more than half of those are students. The rest are skilled workers and people who are less skilled. Education is an important source of British soft power. Britain should not lose its chance to pursue the best brains, regardless of nationality.”